Masco Corporation (MAS) Earnings Call Transcript & Summary

Good morning. I'm Sam Darkatsh. On behalf of Raymond James. We'd like to welcome you to the Masco Corporation presentation for this morning. With us today from Masco, John Sznewajs, Chief Financial Officer; also, Dave Chaika, Vice President, Treasurer and Investor Relations. And without any further ado, John, the floor is yours. Welcome.

Thank you, Sam. And good morning, everybody. So I'm happy to talk a little bit about Masco today. And one of the first things I want to talk about is the transformation that we've accomplished over the last several years is we've changed really the -- significantly the profile of the business. So on this slide, you can take a look. If you roll the tape back just 6 years ago to 2014, we were a much, much different business. We had 5 operating segments that we reported. About 30% of our revenue was devoted to new home construction with operating margins of about 10%, with significant shares outstanding, and we -- our gross debt-to-EBITDA was over 3x. And systematically, over the last 6 years, we -- when Keith Allman, our CEO, came on board, we did a portfolio review and really decided that what we wanted to be coming out of the Great Recession was a company that was more focused on repair/remodeling, so less cyclical, more resilient because of the earnings profile and the growth profile of our paint and Windows -- our paint and plumbing business. And so over the years, we've done a couple of things. One, we spun out TopBuild, our contracting business. And then in March of last year, we announced the fact that we were going to sell our cabinets and Windows business. And we completed the sale of our Windows business in November, and we just completed the sale of our cabinets business in -- a couple of weeks ago. So now as you roll the tape forward to at the end of 2019, really we're 2 segments, 90% focused on repair/remodel activity. So again, low volatility, low cyclicality. You can see that -- the margins of the 2 businesses at 16.5%. We've done a heck of a job redeploying the capital that we generated. And one of the hallmarks of Masco is our free cash flow generation, and I'll touch on that. So we've taken a good chunk of our shares out, taken about 20% of our shares out over the course of the last 6 years. We've raised our dividend each of the last 6 years. And we've done a nice job of delevering by knocking out a fair amount of debt while EBITDA has grown. So quite a transformation. And we're really proud of where we're at. We're really pleased at how we're set up to go over the course of the next several years. So taking maybe a little bit deeper look at the company. Here are the 2 operating segments that we report. And so you can see that Plumbing Products is about 60% of our revenue. About 85% is in repair/remodel. We do sell a little bit on the new home construction side. And it's a little bit more diverse internationally, about 65% of our sales here in North America. The balance, 35%, is international. A big chunk of that is Western Europe. And you can see on this chart that China represents about 3% of our total sales. Turning to the Decorative Architectural Products, really 3 companies or 3 types of companies in there. One, the biggest portion is Behr paint, but we also have a lighting business and a hardware business in that segment. And you can see that that's practically all repair/remodel and all here in North America. So as you roll it all up, you'll see that we finished 2019 at about $6.7 billion in revenue, 90% repair/remodel focused and 80% focused in -- here in North America. So one of the hallmarks of Masco over the years has been our leading brands. And whether it's Behr paint, the leading DIY brand here in North America; Delta Faucet, where we think we have the leading share in faucets and showers here domestically. We've got internationally both Hansgrohe, which is a higher-end German brand that sells into more than 140 markets around the world; as well as Axor, their premium price point, a lot more luxury offering; and then Kichler, the lighting business that we acquired in 2018. One of the keys that supplement the brands is innovation. You won't have good brands unless you have good innovation. And so this is another thing that Masco has done very well over the course of the last several decades. You can see that about 30% of our revenue in 2019 came from products that we introduced in the last 3 years, and that's something that we continue to focus on because between the complement of our brands and the innovation, that gives us the must-have position on the shelves of our retail and channel partners. And so whether it's product innovation, like some of the things you see on this chart here, or whether it's merchandising innovation. One of the items on the bottom is the fact that we recently reset all The Home Depot stores to make the purchase shopping experience better for the DIY consumer within The Home Depot. And then lastly, when you have brands, you have innovation, you have to have good distribution. And we look at this in a couple of different ways. One is through price points, and we always want to have a good or best offering. And so you can see that we accomplish that, and we use our various brands to do so. So whether it's BEHR PREMIUM PLUS in the opening price point, BEHR PREMIUM PLUS ULTRA in the mid-price point or BEHR MARQUEE in the high price point, we cover all the places where consumers may want to shop. But then we also know we want to be everywhere the consumer is shopping. And so today, that's -- a lot has changed over the course of the last several years. Clearly, we want to be with the big-box retailers, and we've got great sales with both Home Depot and Lowe's and Menards. But we also sell to wholesale distribution, and that's where we really grew up selling to 2-step channel partners such as Ferguson, Hajoca, Southern Pipe for our Plumbing Products. We also do sell in e-commerce. So we sell through the traditional e-commerce retailers that you might expect. So we sell to Amazon, Wayfair, Build.com. But then we also are big in both Home Depot and lowes.com as well. And then we have a number of companies that sell to specialty retailers. So we think of our hot tub business go through specialty dealers that sell only hot tubs. So as we think about what impacts the repair/remodel market, it's these 5 factors. And we think over the course of the next several years that the repair/remodel market will grow about 1% to 2% above GDP. But the 5 key things that we really watch is home price appreciation. So obviously, if a consumer's biggest asset is appreciating, they're more willing to invest in it. And so that's a big piece of it. Obviously, age of the housing stock in North America is old and getting older by the day. So it's -- the average age of the house in the United States is now about 40 years old. Household formations had been lagging as we were coming out of the Great Recession. And over the course of the last several years, we've seen household formations pick up nicely. And so that often leads to existing home turnover. If you look at the data points for existing home sales in the last several months, obviously, they've been picked up. I think in the most recent reading, existing home sales have picked up about 3%, and that was the late December-early January reading. And then finally, consumer confidence. If consumers feel good about their job, feel good about their wage increases, all that leads to them reinvesting in their home, which is oftentimes their biggest personal asset. As I mentioned a few minutes ago, the biggest driver -- or one of the most powerful things about Masco is our ability to generate free cash flow. So over the last several years, we've had a free cash flow conversion running in the 100% range. And you can see here we ended 2018 with about $600 million of cash on the balance sheet. We received net after-tax proceeds from the 2 divestitures that I mentioned a few minutes ago of sales of -- or proceeds of approximately $1.2 billion. We anticipate cash flow from operations over the course of the 3-year period 2019 to 2021 to be approximately $2.7 billion. And then you can see the uses of our cash really aren't all that significant because we're not a very capital-intense business. So CapEx over that 3-year period will run about $500 million or just over 2% of sales. We do pay a dividend, and we think it's important that we pay a relevant dividend. And so I have about $600 million go out in dividends. And that dividend includes the dividend to our existing shareholders as well as the dividend to our -- we have a minority partner in Hansgrohe, so that's included in that number. We expect to pay down a little bit of debt, and we did so in November of last year. We had a $200 million maturity that is due in March of this year that we paid off early. And we expect to -- we announced on our fourth quarter earnings call a couple of weeks ago our intent to wrap up our pension plans over the course of the next couple of years. And so that will require some incremental contributions over the next several years. So that leaves us about $2.5 billion to deploy to either share repurchases or acquisitions. And we did a fair amount of share repurchase last year, over $800 million of share repurchases last year. And we've indicated, absent a compelling acquisition, that we would devote the balance of the proceeds from the sale of our cabinet business that we received a couple of years ago, along with the strong free cash flow that we generate, to share repurchases over the course of 2020 and 2021. So -- and really -- and then we still end the period 2021 with great, great liquidity. So to wrap it all up. A lot going on at Masco over the last 5 or 6 years, but we think all for the good. So we refocused the portfolio on low-ticket, more resilient repair/remodel products. We feel we've got great opportunities for continued growth across our platforms, either in the paint segment or the plumbing segment. We've got great free cash flow, and we continue to allocate that capital back to the shareholders. You can see here that our growth targets are modest, 2% to 3%, but we expect high operating margins, and we expect EPS next year to be in the $2.80 to $3 range, up from -- we're -- this year, we're at $2.35 to $2.55 is our guidance for 2020. So we feel really good about how we're positioned going into 2021. So Sam, that wraps up my prepared remarks. I think we'll turn it over to Q&A.

Okay. Questions. I'll start off with, I guess, the perfunctory virus-related questions. So you have finished goods coming out of China with Kichler. And to an extent, with Hansgrohe, you have some component exposure with respect to plumbing. Talk to us about what you're seeing in terms of inventories, vendor lead times. How much safety stock inventory do you have? Give us a sense of how this might affect Masco in the near to intermediate term.

Yes. So obviously, this is a very dynamic and fluid situation. And I'm telling you, where we're at today, to try to predict the future at this point, I think, would be a bit of a fool's game. So where we're at now is coming out of the Lunar New Year, and the Lunar New Year and this virus development, at least for us, the coincidence was helpful because we were heavy on inventory going into the Lunar New Year. And what we've seen post the Lunar New Year is that our facilities in China as well as our suppliers' facilities in China have started to come back online, though they're coming back on, on a delayed basis. They're probably coming back up a week or 2 behind schedule. We feel pretty -- very good about our safety stocks now because of the positions that we had going into the Lunar New Year. A thing that we're continuing to watch is the development of the virus and how that impacts us. We don't -- with China representing only 3% of our sales, it's not a big impact on our revenue. We're watching very closely how the virus develops in Western Europe because obviously, Hansgrohe has got strong sales in Western Europe. The good news is, for us so far, at least, Italy is a very, very small part of Hansgrohe's overall sales, so not much of an impact there. So from a safety stock position, we're -- we feel we're in good shape. It all depends on how -- the rate of development of how this plays out over the course of the next several months, Sam.

And you've indicated, especially after the monetization of your cabinets business, that there should be a significant share repurchase here with the proceeds going towards share repurchase certainly in the first quarter and then the rest of the year from cash from operations. What's your flexibility and/or interest in accelerating the timing of that share repurchase based on where the stock is trading today?

Yes. So we -- the signal that we sent on our fourth quarter call was that we would devote about $1.2 billion to share repurchases in 2020. But again, $645 million of that comes from the proceeds from the cabinets sale; the balance comes from cash that we will generate over the year. And the way that we're thinking about it is, yes, we may front-load it a little bit. We have looked at an accelerated share repurchase, and we haven't pulled the trigger on that at this point, Sam. Could we? Yes, definitely, we could. Obviously, the market has changed pretty significantly over the course of the last week or so. And so our intent is to end the year with between 265 million and 270 million on an average share count basis. So that would require some heavy front-loading of that repurchase activity in order to accomplish that, Sam. So you can -- whether it's significant market repurchases or an accelerated share repurchase, we don't know exactly how that's going to play out just yet.

You mentioned in your presentation both share repurchase and M&A as a use of cash. We've been talking about share repurchase. What are your thoughts with respect to M&A? What does the pipeline or prospective pipeline looks like? And how do you view it in the light now that your valuation, obviously, has come down over the last few weeks or so? How do you balance M&A versus how your own stock is trading?

Sure. M&A has been a big part of our history. And as we look at M&A today, we want to be very disciplined about how we approach it. And so we're limiting our purview on M&A to really just the plumbing and the paint segments. I would guide you to think small M&As. So think $150 million or less in purchase price is what we're taking a look at right now. And we're starting -- we see some small things out there. It's tough. With the public markets coming down very quickly, as you mentioned, it takes -- often takes a long time for sellers' expectations to realign to the public markets. And so we have to face that battle. But we're continuing to prospect, continuing to cultivate these because fundamentally, longer term, share repurchase is a great return of capital to our shareholders. But at the same time, we want to continue to grow structurally our very sound businesses because go -- we have very capable management teams at Delta Faucet, we have very capable management teams at Hansgrohe and at Behr. And we would like to supplement their activity, their growth through M&A if we can find the right acquisition for them.

Kichler has been a bit of a challenge after the acquisition a few years ago, both with respect to margins as well as some lost business and some pressures at retail from inventory drawdowns. Where does the Kichler turnaround story stand at this point? How much of it is internal -- internally controllable versus simply a need for additional volumes from here?

Yes. So to Sam's point, and I mentioned it in my prepared remarks, we acquired Kichler, one of the larger lighting companies here in North America, in March of 2018. And it was -- unfortunately for us, the timing was tough because shortly thereafter, the tariffs were announced and it hit this industry very hard. And so as we look at the lighting industry, we think the lighting industry in 2019 was actually down just given the significant pricing that nearly every player had to put in the marketplace given the impacts of the tariffs on the industry. And so that led to a couple of tough decisions for us. We did put a pass pricing through early and aggressively to our customers. And as a result, as Sam mentioned, we did lose some business at one of the major retailers where, because of our price increases, they chose to rebid a portion of our offering, and they've taken direct in-house through their own private label sourcing organization. And so we've had to restructure the business a bit. So we've had senior leadership changes there. In February, we did announce that we are shutting one facility in the East Coast that principally serves that retail partner. So it makes sense. We're descaling in opportunity -- in areas where we've lost business. That said, fundamentally, we do believe the lighting industry in the long term is a decent business to be in. We like the management team that we've got in place. And so we think that we see opportunities for growth in that business over time. But 2020 is going to be a year of restructuring, and we think we're going to reposition this business and have it in a growth -- in an opportunity to start growing again in 2021.

We talked about your preparations and exposure to the virus out of Asia -- or supply chain out of Asia. What are your retail partners telling you in terms of their own plans for safety stock inventory or purchasing? Obviously, Lowe's had been drawing inventories lower this past quarter. What are the indications they're giving you, not necessarily Lowe's per se, but the retail partners giving you in terms of what their own designs are for inventory plans going forward?

Yes. So we don't like to talk too much about -- directly what the conversations we're having with our customers. That said, we're in regular communications with our customers about our supply chains and where they stand on their inventory positions. And we have got good visibility into point of sale. So we can see how things are going out the door. And all I can say, Sam, on that front is this is a very dynamic situation, lots of conversations between our supply chain teams and their supply chain teams to manage this situation. Right now, given the fact that we produce all of our paint domestically, so there's no impact at all to the paint side of our business. We do have a large number of manufacturing facilities for our Plumbing Products here. But there are some of the higher-volume SKUs that do run through the big box retailers that we do bring in from overseas, and we are in very regular communication with them about the status of things there. And so far, no issues, but we're continuing to monitor the situation.

We have a few minutes left. Any questions from the room? Right here. Okay.

Can you talk about your businesses that are less volatile because of the change that you made? Can you explain over the course of the last quarter that you think why the margins might have been weaker than you expected? I'm just trying to understand why you had that variance and what you think about it going forward.

Yes. So the question, in case you didn't hear that, was given the fact that we've repositioned the portfolio to be more resilient, and I'm paraphrasing, and less volatile, talk a little bit about the fourth quarter of 2019 and what happened there. And so fundamentally, a couple of things. I think what you're referring to is we did have a little bit of margin compression in 20 -- in the fourth quarter of 2019. And really, a couple of things happened there. One, we mentioned the fact that we lost some business at Lowe's with Kichler. But more importantly, I think what happened is, as you think -- consider how we want -- attacked the tariff issue, we went early with price. And so what happened as you roll out through the various quarters of 2020, we probably, in the first part of the year, had price ahead of feeling the cost impact of the tariffs through our P&L. And really, we started to feel a little bit of the cost pressures from the tariffs in the very end of the third quarter, but we felt the full impact of the tariffs in the fourth quarter. And that will continue as we go into the first 2 quarters of 2020. And so as we consider how 2020 rolls out, we'll have a little bit of headwind in terms of margin in the first half of the year, but we see a return to better margins in the second half of the year as the impact of the tariffs flow -- finally flows fully through our P&L. So that's happening. And then the second thing -- the third thing that happened in the fourth quarter of 2019 is if you compare the -- our SG&A costs in the fourth quarter of 2018, we had probably the lowest SG&A costs we'd ever had. And that was just a function of some timing of advertising and the like. And so what you saw is a more normalized SG&A expense in the fourth quarter of 2019 relative to the fourth quarter of 2018.

Other question? All right. Well, we will take this up downstairs in the breakout. Thank you very much, John.

Thanks, Sam.

Yes. Thank you.

Thank you.